Watch for risks in TDFs, portfolio manager warns

Investors and retirement plan fiduciaries want greater returns from their target-date funds, but it is important to know what the risks are.

That’s the word from James Lauder, portfolio manager and CEO of Global Index Advisors Inc., in talking about what he calls return-envy — when retirement plan participants or fiduciaries make decisions based on greed or fear.

“For fiduciaries, it can make them make decisions that aren’t in the best interest of their plan, that don’t really marry to their philosophy of what they’re trying to accomplish for the individual participants. And, for investors, it can lead them to make those self-defeating kinds of decisions that have very negative effects on their long-term retirement-saving success,” Lauder said last week in Wells Fargo’s “On the Trading Desk” podcast.

Lauder believes that it is OK for fiduciaries to envy the performance of other funds, but return-envy is dangerous in target-date funds.

So what should plan sponsors consider when selecting TDFs?

Risk potential associated with a fund manager’s target-date fund approach and whether the manager is an efficient manager are the two biggest items plan sponsors should consider when choosing a TDF for their retirement plan, he said.

Is the risk potential in line with what a plan sponsor feels is appropriate for its participants? The manager’s philosophy and the plan sponsor’s philosophy need to mesh well, he said.

Choosing the appropriate target-date also is important. Choosing a year that’s closest to when a person plans to retire is correct 95 percent of the time, Lauder said. More sophisticated investors may choose to take more risk as they get older instead of less risk, but it is their choice. Individuals need to determine if they can handle the losses that could come from increased risk, he said.

Lauder added that investors should not be complacent in light of the bull market we’ve been experiencing.

“Don’t be blinded by return-envy, and then make sure that you continue to judge your appropriate target-date fund on its ability to deliver efficient performance rather than just delivering absolute returns at any cost,” he said.